COMMODITY-DEPENDENT ECONOMIES? IS IT TIME TO TAKE THE PLUNGE?

COMMODITY-DEPENDENT ECONOMIES? IS IT TIME TO TAKE THE PLUNGE?

Eric Anderson, Managing Partner, Milltrust International LLP, reports?from the Milltrust Annual Emerging Markets Symposium which took place?in London last week?to a capacity audience of investors, and featuring leading managers from Asia, Russia, Latin America and the GCC.?? He weighs up the pros and cons of taking the plunge…?

This has been a dreadful ride for any country reliant on commodities to fund their economies; both the current accounts and capital accounts have been negatively impacted, leaving many countries with massively depreciated currencies, low market valuations and a bleak short term outlook.? In the text below, we update investors on the three big ?commodity-exporting? regions: Latin America, Russia and MENA.

LATIN AMERICA

It?s now time to start selectively buying in Latin America.? Whilst China is moving from an investment-led economy to a consumer-led one, the opposite is true in Latin America which is seeking to address its significant infrastructure deficiencies across the continent. This is opening up a large number of very attractive investment opportunities as each government aims to share the workload through partnerships with private enterprise. Outside of Brazil, Mexico?s structural reforms have been very positive, particularly the energy reforms, which should lead to an accelerating growth trajectory for the country in the medium term; Colombia and Peru have put forward major infrastructure programs which should have a positive spill-over into a number of local industries and help offset the reduction in commodity revenue; meanwhile Chile?s significant structural de-rating over the last few years, partly triggered by the new ?market unfriendly? tax reform, has reached ?bottoming out? territory with very few sellers left.? Finally, with regards to Brazil, the outlook for the rest of this year and next year is bleak with positive growth resuming in 2017; however, in Brazil, it?s all about the politics, and the key trigger to help drive up equity markets will be if the country is able to overcome the current political crisis.

RUSSIA

Russian equity markets provide 30 to 40% upside over the next 12 months assuming oil prices maintain a minimum average price of USD 50 to 60 and there is an improvement in the geo-political situation.? With regards to the economy, the most likely scenario for the next 12 months is a mild recession with real GDP contracting 2-3%, inflation and policy rates declining to less than 10%, and the rouble dropping to a 55-60/USD level.? This would suggest an improving situation in Russia which should help lift the equity valuations off 10 year lows.? Moreover, if the EU sanctions are lifted at the end of the year when they expire, then the markets are probably looking at a significant decline in the equity market risk premium with a likely 30-35% immediate re-rating.? The EU has had a very pragmatic approach with Russia which is likely to help with the quick removal of the EU sanctions once the geopolitical risks subside.

MENA

The Middle East offers investors a great deal i.e.?Emerging Markets growth in USD terms.? Low correlations, healthy country balance sheets, and a strong demographic dividend should provide plenty of upside for investors in the region.? Saudi Arabia is probably the best positioned country with low a debt to GDP ratio (1.6%) and large fiscal reserves making it technically unlevered.? What about oil?? Abu Dhabi can rebuild itself 8 times without oil revenues and Saudi Arabia, 3 times.? Saudi Arabia can also maintain existing spending for 3 years without oil revenues, and 7 years with oil at USD 30.? Whether there is a political agenda or an economic reform agenda, our investment team does not expect OPEC to change its policy anytime soon; we are likely to continue to live in a low oil price environment.? Meanwhile, Dubai, whose economy is driven by services, transport and logistics with only 3% of GDP driven by oil,?is likely to benefit the most with the lifting of the sanctions on Iran.

The Milltrust Global Emerging Markets Portfolio currently has a 14.2% exposure to Latin America, 8.9% to MENA (including Saudi Arabia) and 5.8% exposure to Russia.? The Portfolio has annualised nearly 6% since the launch in 2012 versus the MSCI EM index which has annualised -3% over this same time period.